Cbeyond, Inc. Q2 2008 Earnings Call Transcript

Aug. 6.08 | About: Cbeyond, Inc. (CBEY)

Cbeyond, Inc. (NASDAQ:CBEY)

Q2 2008 Earnings Call

August 6, 2008 5:00 pm ET

Executives

Kurt J. Abkemeier – VP of Finance and Treasurer

James F. Geiger – Chairman, President, and Chief Executive Officer

J. Robert Fugate – Executive Vice President and Chief Financial Officer

Analysts

Frank Louthan – Raymond James

George Sutton – Craig-Hallum

James Breen – Thomas Weisel

David Dixon – FBR Capital Markets

Michael Rollins – Citi Investment Research

Jonathan Schildkraut – Jefferies

Eric Kainer – Thinkpanmure LLC

Operator

Welcome to the Cbeyond, Inc. second quarter 2008 earnings results conference call and webcast. (Operator Instructions) At this time for opening remarks and introduction, I would like to turn the call over to Vice President, Finance and Treasury, Kurt Abkemeier.

Kurt K. Abkemeier

I’d like to begin today's call by reminding you that this call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements include, but are not limited to statements identified by words such as believes, expects, anticipates, estimates, intends, plans, targets, projects and similar expressions. Such statements are based upon the current beliefs and expectations of Cbeyond's management and are subject to significant risks and uncertainties. Actual results may differ from those set forth in the forward-looking statements.

Factors that might cause future results to differ include, but are not limited to, the following: the risk that we may be unable to continue to experience revenue growth at historical levels; changes in federal or state regulation or decisions by regulatory bodies that affect the company; periods of economic downturn and the impact on our results of operations and access to capital markets; the impact of certain of our customers to meet their payment obligations; the timing of the initiation, progress, and cancellation of significant contracts or arrangements; the mix and timing of services sold in a particular period; competitive factors; our ability to recruit and maintain experienced management and personnel; rapid technological change and the timing and amount of start-up costs incurred in connection with the introduction of new services or the entrance into new markets; our ability to maintain or attract sufficient customers in existing or new markets; our ability to respond to increasing competition; our ability to manage the growth of our operations; changes in estimates of taxable income or utilization of deferred tax assets which could significantly affect the company's effective tax rate; and general economic and business conditions.

You are advised to consult any further disclosures we make on related subjects in the reports we file with the SEC, including the risk factors in our most recent annual report on Form 10-K, together with updates that may occur in our quarterly reports on Form 10-Q and current reports on Form 8-K. Such disclosure covers certain risks, uncertainties, and possibly inaccurate assumptions that could cause our actual results to differ materially from expected and historical results. We undertake no obligation to correct or update any forward-looking statements, whether as a result of new information, future events or otherwise.

On the call today, we have Jim Geiger, Chairman, President, and CEO, and Bob Fugate, Executive Vice President and CFO.

That said, I’ll turn it over to Jim Geiger.

James F. Geiger

Today we’re talking about the financial and operating results for the second quarter of 2008. We are very pleased with the results of our business in Q2. In the second quarter we posted record quarterly gross additions, grew customers by 23.7% year-over-year, grew revenues by 25.7% year-over-year, and I might add, 100% organic growth, posted sequential quarterly growth in revenue of $4.6 million; grew ARPU from $7.48 last quarter to $7.54 in Q2; maintained customer churn at 1.3% for the quarter while continuing to reduce bad debt expense; grew applications used per customer to 6.5, with 28% mobile penetration of the customer base; and an increased mobile attach rate of just under 50% of new sales.

We continued the ramp of recently launched markets in the San Francisco Bay area and Miami, began serving customers in our 11th market, Minneapolis; and recorded solid adjusted EBITDA margins across our markets.

I’ll just note here briefly that consolidated adjusted EBITDA was generally below analyst expectations in the quarter for two primary reasons. First, we recorded a lower than typical level of recoveries of access and other telecommunications costs that were originally billed in error by our major telecommunications vendor. We averaged $1.1 million of these credits per quarter over the last four quarters. We expect to catch up on these operating expense credits in future periods and Bob will explain this topic in detail for you later. The second point is that we planned to incur losses and did take on an additional $1.1 million of adjusted EBITDA losses from new market launches in Q2 ’08 versus Q1 ’08. As you may recall, we had five early stage markets this year versus three at this time last year.

On our last call we spoke about our execution in Q1 related to sales and receivables management. I’m pleased to report that in Q2 our execution in these two key areas improved while the economy did not appear to worsen, at least in its effect on our business.

I’ll begin my detailed comments today with the topic of churn. As mentioned previously, churn was flat with Q1 at 1.3%. Consistent with our history, our controllable churn, which includes customers leaving for service or pricing reasons, has remained at 0.4% of our customer base while uncontrollable churn, which includes customers leaving for reasons outside of our control, mainly for non-payment, was 0.9% of the base. We always strive for improvement in churn quarter-over-quarter; however, the continued poor economic climate made that goal unattainable in Q2.

While we didn’t see an improvement in the churn rate for the second quarter, we saw a marked improvement in the health of our customer base. Our customer receivables over 60 days have dropped to 6% of total receivables at June 30 from 12% at December 31. Our allowance for doubtful accounts has dropped 34% over the same period due to the cleaner composition of our receivables. In addition, we reduced bad debt expense from 2.7% of revenue in Q4 to 1.8% in Q1 and further down to 1.6% in Q2. Based on data from Experian, we divide our customer base in terms of credit quality and the data is reassuring. For example, we have 38% fewer customers in the high credit risk category than Experian’s total business population, and 44% more customers in the lowest credit risk category than the small business population in general. Regarding specific verticals, the 5 real estate and construction related sectors have continued to be an outside percentage of our customer churn since late ’07. They represented 13% of our churn in Q2 while only 7% of our customer base, fairly consistent with Q1.

The improvement in receivables and the churn of poor paying customers in the last several quarters have greatly improved the quality of an already healthy and high quality customer base. In addition, many of our significant verticals are highly stable, professional services organizations, which are under represented in our churn such as medical and dental offices, legal, accounting, and other professional services. Together, these four verticals were 12% of our customer base, but only 7% of our churn. We believe Cbeyond has one of the premium quality customer bases in the small businesses services sector and the strengthened credit quality resulting from our credit policies should further position us for the opportunity to reduce churn going forward.

Next I’d like to discuss the growing strength in our sales area. Despite the challenges created by the country’s continuing economic problems, we were able to increase the number of new customer contracts signed in the second quarter by 9% above our first quarter levels. In the second quarter we installed over 3300 new customers, otherwise known as gross additions, which represented a strong 11% sequential increase over Q1 gross additions. Our results from July indicate that we should be seeing continued growth in the level of new customers signed this quarter over Q2, which in turn will have a positive impact on gross additions in Q3. Investors have often asked if we are seeing our oldest markets cresting or declining in terms of sales and this has clearly not been the case. I’m pleased to state that Atlanta was our top performing market in the quarter. Dallas was our next performing market, only a few units behind Atlanta. Dallas posted the most quarterly adds it has recorded in the seven years it’s been in operation. Several of our other markets also turned in solid performance, and the newly launched markets were well on track, but a few remain a bit below our expectations, having been affected by the economy to varying degrees.

In terms of what companies and other industries call same-store sales, our year-over-year revenue growth of our first six markets are profitable ones with 20% in Q2 over Q2 of last year. As to competition, the trends remain unchanged through Q2. Despite some recent predictions to the contrary, our loss to cable competition has remained immaterial as in the past, and what little churn to cable there has been was mostly business accounts downsizing to residential. We take the potential competition from cable seriously and continue to believe that they’ll be successful in the residential, small office home office, or SOHO, space, but we maintain that any success they are achieving is coming at the incumbent’s success and not ours. We’re not seeing them as a competitive factor in sales situations.

At the beginning of the call, I noted that ARPU increased by $6.00 in Q2 to $7.54 from $7.48 in Q1. Our fixed price bundles approach is key to understanding Cbeyond’s ARPU; in fact, as Bob will discuss further, 7% of our revenue is usage base which varies month to month with customer activity. The strength in ARPU we’re seeing gives me confidence that customers continue to place a high value on our integrated packages and the use of our additional applications. Last quarter we noted the introduction of hosted Microsoft Exchange and Secure Desktop. These new products look to be real winners for us but are still just getting off the ground and haven’t had a chance to really influence ARPU yet, so we’re really hopeful that we’ll see continued strength in ARPU going forward as we broaden application usage throughout our customer base.

The combination of increased customer additions, flat churn, and higher ARPU levels contributed to our solid revenue growth in the quarter. Our sequential quarterly revenue growth was $4.6 million, which was 6% approximately growth from Q1 and 26% approximately year-over-year. At this point, we expect this acceleration in quarterly revenue to continue in future quarters.

Moving on to new markets, at the end of the second quarter we launched service in our 11th market, Minneapolis. Minneapolis has about 40,000 small businesses and relatively low cost for accessing customers, and we believe it will prove to be a successful market for us.

Next, today we’re announcing that the Greater Washington DC area will be Cbeyond’s 12th market. This market has 105,000 small businesses, the third largest market in the country behind Los Angeles and Chicago. We expect that the demographic compositions of the Greater Washington DC area will lead to a very successful business for us long term. We expect to install our first customers in the DC area by the end of the year.

Finally, I’m pleased to provide a brief regulatory update today. As you may recall, in Q4 the FCC struck down Verizon’s petition for forbearance in which Verizon requested that the FCC set aside provisions of the requiring them to lease circuits on a wholesale basis to us as unbundled network elements. Last week the FCC also unanimously rejected Qwest’s similar forbearance petition in four major cities, including Denver and Minneapolis. We applaud the FCC’s action in reaffirming the benefits of fair competition to the public in accordance with the Telcom Act of ’96.

With that said, I’ll now turn the call over to Bob Fugate to provide more detail on the numbers.

J. Robert Fugate

I’ll now go over the detailed operating metrics and financial results for the quarter ended June 30, 2008. Starting with our customers, we ended the quarter with 38,576 customers, compared to 31,175 customers in last year’s period, representing a growth rate of 23,7% year-over-year and 5.2% quarter-over-quarter compared to Q1’s customer count of 36,674. Net customer additions for the quarter were 1902 versus 1633 in Q1.

Moving on to revenues, we recorded $85.1 million in the second quarter of 2008 versus $67.7 million in the second quarter of last year and $80.5 million in the first quarter of 2008. Our revenue growth rate was 25.7% year-over-year and 5.7% sequentially, representing a $4.6 million increase in revenue from Q1. ARPU, or Average Revenue Per Customer Location, was $754 during the quarter, compared to $748 in Q108 and $748 in Q207. In the second quarter, a variety of factors impacted ARPU, but the majority of the increase was due to an increase in revenue from additional mobile and landlines, other applications, and increased mobile usage. I’d like to comment a bit on the composition of our ARPU in light of recent trends in the economy that have been affecting some telecom companies.

As Jim noted, Cbeyond’s ARPU is characterized by a fixed price bundled approach to services. Our customers generate a recurring revenue stream which includes the base package, additional lines, applications, and a few other assorted categories. All of these combined constitute 93% of our ARPU. Only 7”% of our ARPU is variable, comprising additional mobile and long distance usage above the base package as well as terminating access charges to other telecom carriers. Our business model provides for stable and predictable ARPU due to the fact that it is predominantly derived from fixed price packages, contains no wholesale element, and has very little usage based components. In fact, we believe one of our major competitive advantages in the marketplace is the fixed nature and predictability of our packages for the customer. It also insulates us from significant seasonality while providing visibility into our business.

To summarize our outlook for ARPU, as we’ve stated before, we see the general trend in ARPU as stable to moderately increasing as we increase the value of what we include in our bundle and increase our application penetration with our customers.

Moving on to expenses, our cost of service as a percentage of revenue was 32% during the second quarter, compared to 31.1% in Q108 and 29.8% in Q207. Cost of revenue was primarily impacted by lower than typical telecom cost recoveries. These represent the results of our efforts to correct the complex and erroneous bills that we routinely receive from our telecom suppliers, principally the Bells. They are an ongoing operating activity in each period but they fluctuate in volume from quarter to quarter. These cost recoveries were $800,000 in the second quarter of 2008 as compared to $1.4 million in the first quarter of ’08 and a quarterly average of $1.1 million over the last four quarters.

Besides telecom cost recoveries, cost of revenue was impacted by planned, increased pressure on gross margin from additional early stage markets, the growth in mobile services, and increased losses from mobile handset subsidies. At this time we expect operating expense credits resulting from telecom cost recoveries to increase in the latter half of 2008 due to the anticipated resolution of certain major outstanding bills. As we stated in the past, an aside from the effect of these fluctuations in telecom cost recoveries, we generally expect that gross margins will decline modestly over time, primarily due to the success of our mobile offering and its growing impact on the business and also due to the larger number of startup markets operating at early stage gross margins. However, I’ll note that adjusting for a more normal rate of access cost recoveries in the quarter, our gross profit per customer actually would have been slightly higher in Q2 than Q1.

Turning to selling, general, and administrative expenses, SG&A as a percentage of revenue was 55.3% in Q208 compared to 54.6% in Q108 and 55.3% in Q207. The recent market launches of Minneapolis, Miami, San Francisco, and Detroit have had a significant and fully expected negative impact on SG&A margins. We anticipate that as the proportion of new markets to the total number of markets declines, we will see significant SG&A leverage. During the second quarter we reduced bad debt expense as a percent of revenue to 1.6% from 1.8% in the first quarter. We actually reduced quarterly bad debt expense by 34% from $2 million in Q407 to $1.3 million in Q208 while increasing revenue by 10.7% over that period. In addition, we reduced our customer receivables that are past 60 days from 12% in Q4 to 6% in Q2 and dropped our days sales outstanding to 26.3, our lowest level in the past couple of years. We believe that this rapid improvement in bad debt expense as a percent of revenue back to historical norms is evidence that we made the right decision in tightening credit and improving the quality of our customer base in these uncertain economic times.

Next I’ll speak briefly about non-cash share based compensation expense. Non-cash share based comp expense was $2.8 million in the second quarter of ’08 versus $3 million in Q108 and $2.5 million in Q207. Although we exclude non-cash stock compensation expense from our reported adjusted EBITDA, we record this item as part of our SG&A expenses. With respect to non-cash share based comp going forward, this is impacted by a number of factors so it’s not entirely easy to project, but our current expectation for 2008 is an expense of $13 million to $14 million for the whole year. Excluding the effect of this non-cash compensation expense on SG&A, as a percent of revenue, SG&A was 52% in Q208 compared to 50.9% in Q1 and 51.6% in Q207.

Our consolidated adjusted EBITDA was $13.7 million in the second quarter versus $14.5 million in the first quarter of ’08 and $12.6 million in the second quarter of ’07. Just briefly to touch on the definition of adjusted EBITDA, the exclusions include non-cash share based comp expense, loss on disposal of property and equipment, and other income and expense. The full detail of the reconciliation is included in our press release. In considering adjusted EBITDA performance, it’s really worth noting that we are currently carrying 5 early stage negative EBITDA markets this year versus 3 last year. These 5 early stage markets created a $5.2 million drag on adjusted EBITDA in Q208 versus only a $2.3 million comparable figure for Q207 and $4.2 million in Q108. Our six EBITDA positive markets posted $38.7 million in adjusted EBITDA in the quarter and our negative adjusted EBITDA at corporate declined slightly as a percent of revenue in Q2 versus last quarter.

Our depreciation and amortization expense came in at $9.5 million in Q208 compared to $9 million in Q108 and $7.6 million in Q207. In the second quarter we recorded an income tax expense of $400,000 versus $40,000 in the second quarter of ’07 versus 2007 income tax expense increased as a percentage of income before taxes as a result of our having begun to record income taxes at the full corporate tax rates and due to an increase in the Texas State Margin Tax, both of which occurred in the first quarter of 2008. Prior to 2008 we had a full valuation allowance against our net deferred tax assets. Under this scenario we recognized income tax expense generally based on the amount of taxes actually payable with some technical accounting exceptions and due to our net operating loss carry forwards, our taxes were based on the alternative minimum tax rate which is lower than the full corporate tax rate. Although we’re now recording income taxes based o the full corporate rate, we estimate that because of our remaining NOLs, we will not be paying substantial cash taxes until at least 2011.

As we’ve stated before, although we’re not currently managing to net income, we posted positive net income in each quarter since we went public in November of 2005. We posted net income of $0.5 million in the second quarter compared to $1 million in the first quarter of ’08 and $2.9 million in the second quarter of ’07 when we were recognizing a lower level of income taxes as described a few moments ago.

Next, capital expenditures. Our capital expenditures were $18.2 million in the second quarter compared to $15.6 million in Q1 of ’08 and $12.8 million in Q2 of ’07. Once our markets have been in operation over three years, we target CapEx to be at 5% to 10% of revenue in these markets. For our first six markets, our CapEx in the second quarter was 6.2% of revenue. Our corporate capital expenditures were $9.1 million in the second quarter compared to $5.3 million in the first quarter of ’08 and $5.7 million in the second quarter of ’07. Most of the increase in corporate CapEx in the second quarter resulted from software license purchases and data center expansion, investments which are essential to support our level of growth and maintain our quality of service.

Regarding the balance sheet, we had a cash, cash equivalents, and marketable securities position of $42.8 million at June 30 versus $46 million at March 31. The decrease in cash in the second quarter is primarily due to our increase in capital expenditures in the quarter. We expect that we’ll continue to maintain a strong cash position going forward. We have no debt outstanding and a $25 million credit facility in reserve which we currently do not expect to borrow under.

Lastly, I’ll walk you through our updated guidance for 2008. Our updated guidance is $350 million to $355 million, adjusted EBITDA of $60 million to $62 million, and capital expenditures of $68 million to $70 million. Our revenue guidance assumes no change in the current economic conditions. We believe we have an equal chance of hitting the upper or lower end of the revenue range. In order to meet the upper end of revenue guidance, we would need to see higher levels of customer growth than we currently expect, along with reductions in churn. In order to land at the lower end of revenue guidance, we would have to see lower volumes of customer additions than we’re currently achieving and increased churn levels, both of which would represent a significant deterioration in our business away from the current positive trends we are seeing. Currently we expect revenue to be at the midpoint of the guidance range. We’re maintaining our prior guidance on adjusted EBITDA which assumes that telecom cost recoveries increase in the latter half of ’08. Unfortunately, while these telecom cost recoveries are an ongoing part of our operating activities and have an impact on adjusted EBITDA, they can fluctuate significantly from quarter to quarter as shown in our Q2 results. We may continue to see that type of fluctuation again in subsequent quarters, either higher or lower, which would affect quarter to quarter EBITDA comparisons. We tightened the guidance range for capital expenditures due to our greater visibility at this time.

And now at this time I’ll turn the call over to Jim for a few final remarks before Q&A.

James F. Geiger

From Day One we built Cbeyond according to a highly differentiated business model and strategy. We focus on the many small businesses that are sophisticated in their own business but not particularly sophisticated in terms of their telecommunications and IT needs, which makes our service highly valuable to them. Our business model is 100% retail, without any wholesale exposure, and 100% of our customers take our application packages, meaning that we have no revenue streams from single-threaded low margin product lines. Precisely because of our strategy to focus on this segment of the market and bring them a valuable package of applications, we’ve been able to maintain high organic growth rates with high stable margins and ARPU. Through this successful business model in Q2, we delivered increased ARPU, accelerated quarterly revenue growth, and robust same-store sales growth. Again, all organic. The purity, simplicity, and predictability of our business gives us a great deal of visibility into it and what we’re seeing continues to encourage us. As I stated earlier, our execution has been improving, while the economy has not worsened in its impact on our business. We are confident about our business and its prospects, and we believe we are doing the right things that will enhance the value of your investment over time. For those of you who have entrusted us with your investment, thank you.

At this time we’re available to answer questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Frank Louthan with Raymond James.

Frank Louthan – Raymond James

Is there any change in customers that you’re targeting in the new markets, has there been any change of direction to the sales force that maybe helped as you’ve improved sort of on the credit quality and so forth, and then when we’re thinking about some of your markets, particularly in Minneapolis, you mentioned there, where are the loop rates there relative to some of your more mature markets? Where can we expect the margins and a mature level to eventually shake out? Are they going to be closer to where Atlanta is or closer to Dallas? Can you give us an idea there? That would be great.

Kurt J. Abkemeier

Let me clarify your question on targeting customers. We have a new credit policy that’s applied uniformly across the nation, not necessarily differentiated. The credit policy distinguishes by credit grade as we achieve through Experian, so I think there are businesses, and I think what you’re getting at maybe as SIC codes of mortgage and construction and real estate related. If the client has a healthy score, and there are very healthy businesses in those SIC codes, we would accept customers in those SIC codes, but I think that’s what the question you’re asking. Would you clarify?

James F. Geiger

I’ll address your question about the loop rates and new markets and their impact on our margins longer term. We’re looking at our newer markets being Miami, Minneapolis, now Washington DC and San Francisco, and San Francisco will really be similar to our other California market margins, but just in general, if you think about a mature, I hate to use the word mature, let’s say a steady state run rate after several years of EBITDA margins that might be in the range of let’s say the low 40s as a percent of revenue up to the high 50s, I would say that a couple of our newer markets, the Midwest ones, would be at the higher end of that range and the other ones, the DC, Miami, would probably be more at the lower end of that range, so it’s really all mix and we expect it to be a mix continuing to go forward as we add some of these other new markets that are on our road map.

Frank Louthan – Raymond James

Jim, you mentioned at the last call that you’re expecting churn to be back to historical levels by year end. Is that still a reasonable expectation or is it going to take a little longer to get there?

James F. Geiger

We thought so, Frank. I guess we have a little bit more of a conservative outlook after this quarter. I think if the economy remains as it is, the impact on our business as the economy is today, we think that we will improve churn but I don’t believe that it would be by the end of the year, we’ll get to those levels.

Operator

Your next question comes from George Sutton with Craig Hallum.

George Sutton – Craig-Hallum

Recently a few analysts have assumed that the very poor results from some of your broadly defined comps would result in pretty Draconian impacts to your business. I’m just curious, which companies in the broader space do you internally focus on the most in attempting to match up your own results?

Kurt J. Abkemeier

I thought that was going to be an easy question. We are certainly mindful of the other people in the communications services space and their business strategies. We’ve always maintained that there is no one that’s like us and I think part of what we are trying to articulate today on the call was that our business strategy is different. We certainly have had some impacts from the economy, but we’ll take our strategy any day. A very integrated, compelling package of services that as Bob said was 93% fixed, long term contracts, three year contracts. We think a very healthy customer base and certainly as reflected in the gross margins, ARPU, incremental revenue, in a very tough economy, we’re very proud of the results of our business. Again, software focused... we have a very differentiated business model, of courser the technology platform and we don’t really compare ourselves to anyone that we compete with for customers because largely no one is offering the same plethora of services that we are

George Sutton – Craig-Hallum

I think that’s the key answer. One other thing, with regard to mobile, what has, in your view, caused the increased attach rate for new customers? Is it related to the Microsoft Exchange or is it something different?

Kurt J. Abkemeier

Too early to tell on the Microsoft Exchange. I think it’s really just the overall value of the package. Maybe it’s our ability to sell it better, maybe it’s the recognition of value. I have always maintained that our customers segment wants more things from a single provider. They want bundling. They prefer having their BlackBerry and their email with the same provider, so we think it’s a trend that’s going to continue to occur and we’re at the front of it, and I would say one other thing, we’re also achieving more success and throwing more resource at our upselling capability, so the penetration of the overall basis has been impact ed by our farmers, if you will, George, instead of our hunters.

Operator

Your next question comes from James Breen with Thomas Weisel.

James Breen – Thomas Weisel

One, which you just touched on a little bit, with your existing customer base, is there taking more products, what are you seeing sort of as the add on? Is there any specific areas where you’re seeing trends? And secondly, in some of our new markets, are you seeing any difference in those markets in terms of sort of the early stage run rates and EBITDA then some of your earlier markets?

Kurt J. Abkemeier

We see a continued penetration of some of the more obvious ones, Jim. The fax to email, I think, has a shockingly high level of penetration where over 60% now of our customer base using our fax to email product. We ended the quarter with 28% mobile penetration. We stand by the prediction we made two years ago that we would have 33% penetration of our base by the end of the year, and we think that we will. Secure desktop is a new product that the way we’ve integrated into Cbeyond online, we think is unique, and a really compelling offer to small business, so while today it’s a very small percent, it’s less than 2% of our customer base, but we just rolled it out nationally, hosted Microsoft Exchange continues at the same levels of attach in the 40% range and we’ve rolled that out to all of our markets in June and the early results are in keeping with what we talked about last quarter about a 20% to 25% penetration is what we’re expecting on the complete package which is the Exchange functionality within hosted Microsoft. Let’s see, your other question was about new market EBITDA.

James F. Geiger

I think generally our new market EBITDA performances is tracking the way we had expected. There are always a few minor variations market by market but in general not of any significance and certainly if we look at the performance of the very recent entries that we’ve had, I think we’re above our plan actually in terms of sales, so that’s going great.

Kurt J. Abkemeier

I would add one negative, Jim, is that in Detroit, we got off to a rocket start in Detroit and it has been a bit weaker over the past couple of quarters, so that trend might not be as good as others in the past.

Operator

Your next question comes from David Dixon with FBR Capital Markets.

David Dixon – FBR Capital Markets

First question was really just in terms of the mix between the economic impact and competition, just wondered if you could characterize the impacts in most terms, not so much from cable, thinking more about the [arlix] there, then secondly, just on the cost recovery, Bob, do you have a sense of how quickly, your best guess of how quickly, you could get that call back? I’m guessing that was the primary reason for the EBITDA or the performance that we saw out of Atlanta and Dallas in the quarter relative to our expectations?

J. Robert Fugate

Well, as I was saying on the prepared remarks, it is unfortunate that a lot of what we might expect to receive in this area sort of becomes earned in a lumpy fashion a times during the year. So it’s very possible that you could see those credits, those benefits, to our income statement increase significantly in as short a time as Q3, but we don’t really know for sure yet even, so I can’t really tell you anything definite. Atlanta and Dallas did have some significant benefits from those cost recoveries in prior quarters recently and so when you look at the EBITDA margins fluctuating a bit, that was a factor there. I’ll just note that there are other factors at work in our business in some of these older markets that come into play and while I’m looking at the EBITDA margin in Atlanta slightly down, I would just caution I wouldn’t take that as a trend. I think that Atlanta’s EBITDA margins will be quite healthy over time and I think you should expect to see that, so hopefully that’s responsive to your question.

Kurt J. Abkemeier

And on the mix of economic and competition on our numbers, we don’t see a competitive impact. We measure those things in a number of different ways, one certainly being the controllable churn. Controllable churn has not moved. The players within competitive losses haven’t changed. There’s been a lot of consolidation in the [CLEC] world and consolidation is generally not a negative, it’s a positive for us in the marketplace, so we don’t see any increased impact from the economy. We are being very tight with our credit policies and that does screen out more customers on the front end which impacts productivity, but that’s no worse and we’re actually adjusting and performing better in the quarter versus last quarter.

J. Robert Fugate

And the component of churn that’s due to competition has remained the same and the component from the economy which we would say is non payment by customers, that’s remained the same.

David Dixon – FBR Capital Markets

And just as a follow up, Jim, you’ve been bang on in terms of the projections for mobile penetration by year end, we’re approaching that date now, what’s your longer term projection there for the mobile penetration? Obviously you’re doing better than expected I think on that front.

James F. Geiger

I would guess that it would start to approach 50% over time which is our attach rate, upwards of that is our attach rate today.

Operator

Your next question comes from Michael Rollins with Citi Investment Research.

Michael Rollins – Citi Investment Research

I was wondering if you could talk first just about the increase in employees. It looked like it was one of the bigger sequential increases over the last couple of years and I was wondering within that context how much went to sales versus other functions, and then just following on the sales idea there, could you talk a little bit about sales productivity, what you’re seeing in your markets, because as you adjust for the expansion of markets, and how that’s relating to the CPGA which on an implied basis has risen year-over-year.

Kurt J. Abkemeier

You can trust that the preponderance of employee increase is sales and service. We’ve been making investments in our service area and in our sales area. One of the areas as well that as I mentioned earlier is in the farming category. We have normal ramps that occur in each one of our markets and those are on track where we go from zero to a full ramp of compliment of 55 to 60 sales reps over 9 months, so that’s occurring. That is, I believe, why you’re seeing an increase in CPGA is because in the new markets there’s an inefficiency that’s occurring and there are more new markets today than there were at this time last year.

Michael Rollins – Citi Investment Research

Productivity?

Kurt J. Abkemeier

Productivity, our internal measure is up in Q2 over Q1 and we think that’s a trend that will continue and I think I mentioned on a call prior about my poor man’s productivity analysis and I think you can do that and find that to be true as well. It’s within a pretty consistent band of what we’ve experienced through our growth.

Michael Rollins – Citi Investment Research

What’s the total sales count that you’re up to?

Kurt J. Abkemeier

We don’t give the specific numbers out on that.

Operator

Your next question comes from Jonathan Schildkraut with Jeffries.

Jonathan Schildkraut – Jefferies

Thanks for taking the questions. A lot of them have been asked and answered so I just want to focus a little bit on the updated guidance. As we’re looking to the back end of the year, do you expect further kind of ARPU increases order of magnitude that you saw this quarter, or should we look more towards kind of the scaling operations from a gross add perspective to lend to that revenue acceleration that you mentioned earlier? Additionally on the EBITDA side, over the first half of the year it looks like you had about $28.2 million at the low end of your guidance range, $60 million that implies $31.8 million over the second half of the year which is an average of $15.9 million which is obviously a lot higher than we’ve seen historically, even if we get to a ramp we’d be looking at a pretty big ramp, so if you could point to some of the things that would really be driving that margin in EBITDA growth in the back half of the year, I’d greatly appreciate it.

James F. Geiger

As it relates to back end ARPU, certainly there is a mixture of nothing of the kind of magnitude we wouldn’t project to occur that occurred this quarter-over-quarter, but slight increases going forward in ARPU, and growth in net adds. We saw strong trend in July continuing off the June numbers and so we believe that it is a combination of both net add growth as well as ARPU.

Kurt J. Abkemeier

On the EBITDA question in the latter half of the year, I think you really need to focus just on the contours of all of the cities and we’re expecting to see continued growth in EBITDA from a number of cities that are already profitable and we’re expecting to see some of the newer markets that have reached some crests in their losses, and a few of them haven’t but for the most part it’s really giving all the segment details that we’ve got, you’d have to just sort of look at them one by one down there and add up the expected changes over the next couple of quarters and that’s really the explanation of why we expect that size EBITDA for the whole year.

Operator

Your next question comes from Eric Kainer with Thinkpanmure LLC.

Eric Kainer – Thinkpanmure LLC

Should we expect any change to your market launch plans? Obviously you’ve announced DC today, your first Verizon market, but should we expect that over time that you’ll either launch more or fewer markets per year as we go forward?

Kurt J. Abkemeier

We don’t have anything that would suggest we’d launch more or fewer at this time. I think it’s something that we just try to be conservative and rational about and we let the business dictate that. While we do have projections of course, I would not give you any information today that would suggest more or fewer.

Eric Kainer – Thinkpanmure LLC

Your growth rate I think most recently you suggested that it might be more along the 27% to 28% type range. We came in just a touch below that and it’s probably easily understandable given the economy that we’re working in. Should we see any expected change to the growth rate over time?

Kurt J. Abkemeier

If anything it will continue to grow. I think that the 26% range this year is probably a good number and we expect it to increase in ’09.

Eric Kainer – Thinkpanmure LLC

Then the last question from me is about inside of your accounts, have you seen a change, especially with the people who are signing up most recently, as far as the number of T1s that they’re taking per account or the number of mobiles that within the mobile account, anything along those lines?

Kurt J. Abkemeier

We aren’t seeing any change. We have three products, BeyondVoice 1, 2, and 3, and they have 1, 2, and 3 T1s of symmetric bandwidth, and we’re not seeing any change in the mix of services, so ARPU isn’t growing because of mix. We are seeing slight increases in the units of mobile attached to an account so the number of devices, but nothing material. I think it’s just really a consistent growth from the consistently higher attach rate of all applications and certainly mobile’s one of the ones that can move the dial more.

Operator

There are no further questions at this time.

Kurt J. Abkemeier

We thank you all for joining us and we look forward to continuing our improved results. Have a great week.

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